The sharp downturn in artificial intelligence stocks is causing a chain reaction on Wall Street. Major banks like Goldman Sachs and JPMorgan Chase have recently issued margin calls to highly concentrated hedge funds, demanding additional collateral to maintain their current leverage levels. Analysts believe this indicates the AI sector sell-off has escalated from market turmoil to credit and risk management concerns.

The Nasdaq 100 index briefly fell 10% from its early June record high during Tuesday's session, briefly entering technical correction territory. SanDisk and Intel have dropped 53% and 39% from their respective peaks, while the Philadelphia Semiconductor Index has lost over a quarter of its market value since late June. This roughly two-week sell-off has disrupted the heavy AI sector bets of many hedge funds, with long-short equity funds and multi-strategy funds declining 1.3% and 1.7% respectively by Tuesday afternoon.

According to a July 29 report from the Financial Times, the margin calls are a consequence of hedge funds significantly increasing their leverage in the first five months of the year. Goldman Sachs noted in a recent client report that the cumulative increase in total hedge fund leverage during this period was the largest single increase recorded since the bank began tracking the data in 2016. This means many funds had substantially magnified their positions through borrowing before the downturn, ensuring losses are amplified when the market reverses.

How Margin Calls Work: Automatically Triggered by Market Volatility

According to reports, sources familiar with the matter said both Goldman Sachs and JPMorgan Chase have asked some clients to post additional collateral. A person close to one of the banks stated: "This is the risk management operation the market should be conducting right now. It's a fairly basic procedure." The source added that many margin calls are automatically triggered by market volatility, a mechanism typically embedded in the agreements between funds and banks. When banks provide financing to hedge funds, they build in protections to shield themselves from losses during market downturns.

Prime brokers provide leverage to hedge funds using stock portfolios as collateral, helping to amplify returns. However, when the market moves against a fund's positions, leverage equally magnifies losses. The banks' risk committees continuously assess the holdings of hedge fund clients and decide whether to adjust or limit the amount of leverage offered to them.

The report suggests the deeper context for this wave of margin calls is that market concentration has climbed to record highs this year. According to Capital Group, the top 10 components of the S&P 500 now account for roughly 40% of the index's total market value, surpassing levels seen during the dot-com bubble in the early 2000s.

In another mid-year report, Goldman Sachs disclosed that as of June 30, approximately 16% of the exposure in its prime brokerage book was directly tied to AI memory chip-related stocks. This figure highlights the increasingly tight risk connection between banks and their hedge fund clients as AI sector concentration rises.